Family Due Diligence: What to Know Before Investing in Another Family-Owned Business

June 28, 2018

Dan, CEO of his third generation, family-owned food distribution company, is interested in growing his business beyond its base in the southeast U.S. and has available capital. Pete’s business operates in California and other western states; as newly appointed CEO of his fifth generation business, he’s anxious to expand his family’s interests. Dan sees opportunity by strategically investing in Pete’s company. Pete is interested in growing his business but wants to ensure that the next generation—his son and daughter—maintains control of the business after his retirement. He considers another family business in his industry a better partner than the financial investors he has talked to, especially given their relatively short-term investment horizons.

Family-owned enterprises operate differently from other companies—business decisions take family dynamics, values, and goals into consideration—but, increasingly, that difference is also a strength, especially when considering investment options. Looking beyond traditional investments in stocks, bonds, or hedge funds, many family businesses are pursuing direct investments in businesses they already know: other family-owned companies. Doing “family due diligence” research can help companies like Dan’s confidently take the next step.

Here’s what you should know before investing in another family-owned business:

Understand your own investment strategy. What are your anticipated time horizons and your return objectives? Dan, the CEO mentioned above, understands that strategic partnerships and joint ventures with other companies offer an opportunity to diversify his business’s operations, as well as expand into other parts of the country, reach new markets, and tap new sources for talent.

Make sure key family members are aligned with your objectives. It’s critical to have open, honest conversations with family members—inside and outside your company—about their goals for the business, often the family’s largest asset.

Understand the target company’s family dynamics, values and succession plan. Develop an understanding of the family dynamics that exist within the target company. This requires an appreciation of its current business and family governance structure. How are key decisions made? How do family members working inside and outside the business feel about another family business investing in their enterprise? Do family members get along? How well are their values and goals articulated and are they in alignment with yours? How has the target company addressed succession in the past and what plans currently exist for the future? Consider bringing in an outside advisor to objectively assess family dynamics in the target company.

Consider the trade-offs you’re making regarding investing in your own enterprise. Are you compromising your company’s long-term growth by not investing in your own human capital, sales capabilities, or infrastructure? Asking this question and evaluating the answer is certainly valid. Investment in another family business should compliment your business plans; it may not limit direct plans for your own business.

Training the next generation. Dan hopes that a strategic partnership with another family-owned enterprise will enable his son and daughter to develop and refine management skills that could ultimately make them more effective business leaders. Will investing in another family business create development opportunities for your next generation of leaders?

Look for deals in an industry where your company already has expertise. How can you immediately leverage your knowledge, experience, and established networks to help your family company investment grow?

Avoid business deals recommended by friends and fellow CEOs. While tempting to explore, these deals may not align with your business’s long-term objectives, family values and family core competencies.

Dan and Pete ultimately reached an agreement benefitting both of their family-owned enterprises: Pete’s company diversified into another market category; Dan’s business expanded its distribution power to the western U.S. and his son and daughter took on new responsibilities in the joint venture. Conducting a family “due diligence” enabled them to confidently take the next step.